Stock Futures Behaviour on Ex-Date of Rights Issue

#1
Hello Alchemist,

I need your help on understanding stock future price adjustment during rights issue. What happens to stock future price during right issue ex-date?

Suppose I buy at cash market and sell futures. I square off the actual shares as well as the future on ex date of right issue. Will this result it no gain no loss situation?

Your suggestion is much appreciated in clearing my doubt as this will be my first exposure to futures and I don't want to take the dive without knowing the exact details.

Regards
Taurus
 

Alchemist

Administrator
Staff member
#3
For stocks going ex-rights, the futures lot is increased in size on ex-date.

The futures lot size is divided by the "adjustment factor" to arrive at the new lot size.

"Adjustment Factor" is less than 1 and so the lot size will increase.

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Let's take the example of Karnataka Bank.

The stock will go ex-rights on 25th February 2011.

Lets assume the closing price of the stock on 24th will be 125.

Rights Ratio A:B = 2:5.
Underlying close price on the last cum date (P) = 125.
Issue price of the rights (S) = 85.

Benefit per right entitlement (C) : (P - S) X Rights Entitlement = 40 X 2 = 80.

Benefit per share (E) : C / A+B = 80/7 = 11.43.

Adjustment factor = (P-E)/P = (125-11.43)/125 = 0.90856.

The futures lot size will increase from 2000 to 2201 on the ex-date.

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The calculation for "Adjustment Factor" is given on NSE's site, but it is incorrect.

http://www.nseindia.com/content/nsccl/nsccl_focorpactions.htm

I have highlighted the correction in bold fonts.
 
#4
Hi Alchemist,

Thanks for the explanation.

My querry is actually for Karnataka Bank only which you provided as an example. I understand that the lot size will increase and the price will get adjusted for futures.

Suppose I buy in cash market and sell futures. On Ex Date I square off everything, will this result in NO loss NO gain situation? (Do not include the gain that will acrue on subscription to the right shares).

Can I take this position to benefit from right issue of Karnataka Bank without suffering any loss on ex date.

An early response will be much appreciated.

Regards
Taurus
 

Alchemist

Administrator
Staff member
#5
Suppose I buy in cash market and sell futures. On Ex Date I square off everything, will this result in NO loss NO gain situation?
You will have losses in your cash market position. This will be exactly balanced by profits from rights shares.

The futures position will results in no loss and no profit.

Let's continue with the assumption that one day before the ex-date, Karnataka Bank closes at 125.

On ex-basis, the stock will go down to 113.57.

If you now sell a lot of 2000 shares at 125, on the ex-day, you will be buying back a lot of 2201 shares at 113.57.

The final result for you will be something like this:

Outflow for 2000 shares (cash market) @ 125 = -250000.
Inflow from futures (2000 shares) @ 125 = 250000.

Inflow from 2000 shares (cash market) @ 113.57 = 227140.
Outflow from futures (2201 shares) @ 113.57 = -250000.
Inflow (final profit) from 800 shares @ 85 = 22856.

Are you getting my point?
 
#6
Hi Alchemist,

Thanks for the clarification. So the end result is there will be loss in cash market (excluding the right subscription gain). But say, if the price falls below 113.57 on the ex-date then the EXTRA loss incured in cash market will be offset through future holdings. Is I am correct?

So cash market loss cannot be ignored for right issue subscriptions by selling futures (I am not including gain from right subscription).

Is the situation same for open offer. Say for Siemens, the offer price is 930 and CMP is 840 and the acceptance ratio will be around 50%.

Can I buy say 1000 Siemens share and sell 500 lot futures and square off everything once the non accepted shares is returned in open offer?

Will this strategy will work so that I do not lose anything (excluding the gain from acceptance from open offer shares)?

Regards
Taurus
 

Alchemist

Administrator
Staff member
#7
Is the situation same for open offer. Say for Siemens, the offer price is 930 and CMP is 840 and the acceptance ratio will be around 50%.

Can I buy say 1000 Siemens share and sell 500 lot futures and square off everything once the non accepted shares is returned in open offer?

Will this strategy will work so that I do not lose anything (excluding the gain from acceptance from open offer shares)?
The April series futures are trading at 813. If you sell the futures at 813, you will have a 32 rupees loss per share.

-There will be transaction costs involved,
-There will be a cost of keeping the money locked for 2 months,
- You will also have to pay higher short-term capital gains tax as the open-offer transaction will be an off-market transactions.

After you consider all the above factors, I doubt you will have any significant profit.

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Suppose you buy 2 shares from the market at 845.

On 1st share you will have a profit of Rs 85.
On 2nd share you will have a loss of Rs 32.

Net profit per share = 53/2 = Rs 26.50.

That's 3.14% profit per share.

Deduct transactions costs, cost of blocking the money for 2 months and capital gains tax.

Nothing much will be left. You may actually end up with a small loss.
 
#8
Hi Alchemist,

Thanks for explaining in such a lucid way.

Can I take the same bet against Patni Computers open offer? Will this make sense? The future and cash price are almost at the same level.

What will be the acceptance ratio as around 30% of shares are held by custodians and against which DR have been issued.

Thanks a lot explaining everything.

Thanks & Regards
Taurus
 

Alchemist

Administrator
Staff member
#9
Can I take the same bet against Patni Computers open offer? Will this make sense? The future and cash price are almost at the same level.
You can try if you wish. After deducting all costs, if you think it is worth your time, you can do it.

The offer shares will be coming back in April 2010.

Thus, you will have to short April series futures.

April futures for Patni are illiquid. The open interest for Patni is just 1500 shares (3 lots).

As on Friday, the best buy price (451) was 1% below the cash market price (456).

Get Quote Details

I am not sure about the acceptance ratio. Public holding in the company is 55%.

This article says the acceptance ratio will be 55%.

If all minority shareholders tender their shares in the offer, the acceptance ratio would be around 55%.
Patni acquisition: the options for minority shareholders - Money Matters - livemint.com

I don't understand how that is possible.

According to the offer document, ADS holders can tender their shares.

The Regulations require that the Offer be for Shares only. Consequently, ADS holders are not permitted to directly tender ADSs. ADS holders who wish to participate in this Offer may withdraw their underlying Shares and tender such Shares in the Offer.
 

Alchemist

Administrator
Staff member
#11
and how is the stock futures position (already taken) decided in case a demerger of business, like that in Triveni recently?
It isn't possible to exactly calculate the value of the demerged entities.

Thus derivative contracts are settled 1 day before the ex-date.

In case of Triveni Engineering & Industries, all derivative contracts were settled on 2nd May 2011.

On 3rd May fresh contracts were introduced.

If you see the data for Triveni's futures on the NSE, you will find that the change in open interest on 3rd May was 1406000 and the open interest at the end of the day was also 1406000.
 
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